Strategic Asset Allocation

Though there are many asset classes, there are only three sources of return: economic growth, money lending, and manager skill. At the heart of designing a strategic asset allocation is a decision on emphasis between these three fundamental sources.

Once an investment objective is determined, it needs to be translated into a strategic asset allocation across the major asset classes. The strategic asset allocation should reflect the risk budget that has been agreed.

Sources of return

Our view is that although there are many asset classes, there are only three sources of return: economic growth; money lending; and manager skill. Thus at the heart of designing a strategic asset allocation is a decision on emphasis between these three fundamental sources of return.

Absolute versus relative return

Given the understandable aversion to losses by investors, there has been a growing emphasis over the last decade on delivering "cash-plus" style returns rather than matching equity market returns. In other words investors have been guided towards portfolios which place heavy emphasis on manager skill rather than economic growth as the primary driver of return. However, as the aftermath of the collapse of Lehman's in summer 2008 showed, no asset classes are immune against black swan events.

Market conditions change

The optimal strategic asset allocation for a client evolves as the outlook for asset classes alters over time. Rather than being a one-off exercise, asset allocation strategy should be reviewed on a rolling basis, with action being taken at the appropriate interval.

Investors need to distinguish between strategic and tactical asset allocations decisions, leaving the tactics to their appointed managers.